Greenspan Says Budget Stakes High Fed Chief Warns Rates Will Rise If Budget Deal Unravels

U.S. interest rates will shoot higher if Congress drops the ball on its pledge to eliminate federal budget deficits over seven years, Federal Reserve Board Chairman Alan Greenspan said Monday.

Investors in financial markets allowed interest rates to fall this year on the belief that lawmakers will make good on promises to reduce government borrowing in credit markets, Greenspan said.

“I have no idea what proportion of the two percentage point decline” in rates on long-term debt instruments this year stemmed from investors’ expectations that the government would slash deficit spending, Greenspan told the Senate Banking Committee.

At the same time, Greenspan said he is sure a “significant” part of the decline stemmed from a belief that Congress will keep its promises to balance the budget.

If Congress is unable to craft a deficit reduction agreement with President Clinton, interest rates will reverse course and begin rising, threatening the economic expansion, Greenspan said.

“The reaction could be quite negative,” he said, predicting that mortgage interest rates and rates in other areas of the economy would rise. Those interest rate-sensitive industries might include autos and major appliances.

If federal budget deficits aren’t cut, higher interest rates will harm sales in those rate-sensitive industries, and economic growth will decelerate, Greenspan said.

His comments came after he and other Fed policy-makers recently left short-term interest rates unchanged in the belief that the U.S. economy will continue to expand without rate cuts.

However, some economists are worried that consumers, spooked by layoffs, already are limiting their purchases. These economists argue that rate cuts are needed.

“Folks don’t see jobs being created, they only see jobs being destroyed,” said John Tuccillo, chief economist at the National Association of Realtors, which reported Monday that home resales fell 1.9 percent in October.